Inflation and taxes

Five years ago, deflation was the big economic fear. But today, massive deficits and unprecedented central bank asset purchases have turned the tables and pushed taxes and inflation to the top of investors' worry list. More than half of the investors surveyed by Fidelity said that tax and inflation strategy had become more of a focus during the past five years. If you want to build your portfolio for the next five years and beyond, you need to consider these risks.

Prepare for inflation. Inflation can erode the purchasing power of savings. Even with a low, 2 percent inflation rate, money held in a money-market fund yielding 0.01 percent is losing money in real terms. Ditto for a Treasury bond yielding 1.92 percent. Investors may consider including in their diversified portfolios some income sources that have some ability to react to inflation – for instance, leveraged loans, TIPS or stocks.

Manage your tax exposure. The first federal income tax increase since the 1990s passed as part of the fiscal cliff deal in early January. With government deficits remaining high, it may not be the last. Savers will need to examine the new tax law and look at ways to manage taxes, including the use of Roth accounts and tax-smart asset location.